Our main point is that more regulation won’t make banks safer and is counterproductive. It is a sort of an instinctive reaction by politicians, policy-makers and regulators to respond to a crisis with more and tighter regulation, in an effort to tackle the ‘excesses’ in the market economy left of its own will. This is both very naive and irresponsible, as much as empirically and theoretically wrong. The recent announcement and approval of the Basell III tighter bank capital ratios is an example of it: this tougher set of regulations was announced and approved in the midst of a severe financial crisis (2008-2010), and resulted in banks shrinking their balance sheets even more; with the expected dramatic fall in money growth and nominal spending.

It is again a dire example of the running of the law of the unintended consequences of regulation; which would recommend the need to assess in advance the expected consequences of regulation, rather than quickly and desperately calling for more and tougher laws on banks and the rest of the financial system.

As we put it in the article:

‘Far too many people believe that “better” regulation is the answer to financial crises. But further regulation involves an expansion of the power of the state, and a loss of freedom for the financial system. Remember that Britain had no explicit official rules on bank capital until the 1980s, yet no British bank suffered a run on its deposits over the preceding century. Crucial to the success of British banking in the decades before the Northern Rock fiasco was the Bank of England’s willingness to lend to solvent banks if they were having difficulty funding their assets. Good central banking helped Britain’s commercial banks to run their businesses efficiently and profitably, and to the benefit of their customers.’

There was a time, not that far away, when regulation was not that prominent and financial markets flourished; and when a banking institution failed, that occasionally they did, there were solid policies and institutions willing to intervene in an decisively and orderly manner (the Bank of England had been an example of that, at least until the collapse of Norther rock in the recent crisis).‘

PS. We will be discussing these issues with the member of the Bank of England’ s Financial Policy Committee, Martin Taylor, in the IIMR Annual Public Lecture on the 7/10 in London: https://www.mv-pt.org/events/public-lecture-the-committee-of-public-safety-the-work-of-the-financial-policy-committee-by-m

The quantity of money matters in the design of a monetary policy regime, if that regime is to be stable or even viable on a long-term basis. The passage of events in the Eurozone since 1999 has shown, yet again, that excessive money growth leads to both immoderate asset price booms and unsustainably above-trend growth in demand and output, and that big falls in the rate of change in the quantity of money damage asset markets, undermine demand and output, and cause job losses and heavy unemployment. This is nothing new. The ECB did not sustain a consistent strategy towards money growth and banking regulation over its first decade and a half. The abandonment of the broad money reference value in 2003 was followed in short order by three years of unduly high monetary expansion and then, from late 2008, by a plunge in money growth to the lowest rates seen in European countries since the 1930s. The resulting macroeconomic turmoil was of the sort that would be expected by quantity theory- of-money analyses, including such analyses of the USA’s Great Depression as in Friedman and Schwartz’s Monetary History of the United States.

This paper argues, from the experience of the Eurozone after the introduction of the single currency in 1999, that maintaining steady growth of a broadly-defined measure of money is crucial to the achievement of stability in demand and output. The ECB did not sustain a consistent strategy towards money growth and banking regulation over its first decade and a half.

Professor Goodhart, indeed a distinguished academic figure in monetary economics in the UK and a former member of the Bank of England’s Monetary Policy Committee, criticised many features of monetary policy-making both before and after the sharp global downturn of 2008 and early 2009. He also underlined some of the most important flaws in current macroeconomic models:

(1) The use of macroeconomic models with no money, nor a banking sector.
(2) No analysis of the monetary transmission mechanisms via the banking or the wider financial sectors.
(3) The assumption that there is a direct correlation between changes in the monetary base and changes in the amount of money.

In my view those flaws are yet to be properly addressed and if we could just agree on those very simple points we would make a major progress in current monetary economics! And we will very much reduce monetary instability and thus minimise the risk another financial collapse.

Just a final note on the Institute of International Monetary Research. Its main purpose is to demonstrate and to bring public attention to the strong relationship between the quantity of money on the one hand, and the levels of national income and expenditure on the other. The Institute has been established in association with the university of Buckingham and is heavily involved in the analysis of banking systems, particularly their role in the creation of new money balances. You can subscribe to its newsletter and publications here: http://www.mv-pt.org/contactus

Juan Castañeda

PS. The text with the lecture will be available soon at the IIMR website.

The Institute of International Monetary Research (IIMR, affiliated with the University of Buckingham) is holding an international conference on the assessment of Quantitative Easing (QE) in the US, UK, Eurozone and Japan on the 3rd of November (London). In the last few years a return to a more conventional set of monetary policies has been widely heralded, and in particular the return to a monetary policy rule focused on monetary stability and the stability of the overall economy over the long term (see the excellent conference organised by CATO and the Mercatus Centre (George Mason University, US) on this very question just few weeks ago); but we believe the first priority at the moment is to analyse and clarify the impact of QE on financial markets and the broader economy. Amongst others, the following questions will be discussed: Has QE been instrumental in preventing another Great Depression? If QE is meant to boost asset prices, why has inflation generally been so low in recent years? Has QE increased inequality? Has QE been able to expand effectively broad money growth? Should QE programmes be extended at all? These are all vital questions we will address at the conference.

The conference is by invitation only and there are still (very few) places available, so please send an email to Gail Grimston at gail.grimston@buckingham.ac.uk should you wish to attend. It will be held on Thursday 3rd November 2016, in collaboration with Institute of Economic Affairs (IEA), at the IEA headquarters in London. You will be able to find a programme with all the topics and the speakers here As you will see we are delighted to have an excellent panel of experts on this field from the US, continental Europe and the UK. There will be of course very well-known academics but also practitioners as well as central bank economists. In particular economists such as George Selgin (CATO), Kevin Dowd (Durham University), Christopher Neely (Federal Reserve Bank of St. Louis), Ryland Thomas (Bank of England) or Tim Congdon (IIMR, University of Buckingham) amongst many other very distinguished economists will be giving a talk at the conference, which provides a unique opportunity to analyse in detail the effects and the effectiveness of QE in the most developed economies.

For your information you can also follow the conference live/streaming; please visit the IIMR website this week for further details on how to follow it remotely on the day. In addition the presentations (but not the discussion) will be filmed and published on our website later on. Drop us an email (enquiries@mv-pt.org) should you want to be updated on the Institute’s agenda and latest news.

A new monetary research centre has been established in collaboration with the University of Buckingham early this year, the Institute of International Monetary Research, to study something we should not have ever forgotten, the importance of the analysis of money growth in any modern economy. I know, it sounds simple and even obvious but it happens that we have disregarded monetary analysis for far too long, perhaps under the overall dominant presumption at the time that just by focusing on stabilising CPI inflation (around a low but still positive rate of growth) the economy could maintain a stable rate of long term growth. As stated on the Institute’s website, its mission is quite clear:

“The purpose of the Institute of International Monetary Research is to demonstrate and bring to public attention the strong relationship between the quantity of money on the one hand, and the levels of national income and expenditure on the other.”

Of course, central banks claim they have always paid attention to monetary aggregates; you may ask, ‘how could a central bank forget about money?!’ Well, let’s start saying that some have indeed forgotten more than others, and even those which did explicitly include a monetary analysis in its reports and in the communication with the public usually gave far more weight to other (macro) indicators in the making of monetary policy decisions, to say the least … . The facts well speak for themselves, and this is what clearly happened, at the very least in the 4-5 years prior to the outbreak of the Global Financial Crisis (GFC). We have seen again booming broad money growth during the last phase of the expansionary years prior to 2008 and then a sudden collapse in the midst of the GFC. The consequences and the impact on output growth have been enormous and this is another reminder on the key importance of keeping a stable rate of growth of money on long term basis as a policy goal. Those familiar with this blog will not find surprising my emphasis on monetary stability (see just a recent post on the topic here; let me say that I myself devoted my PhD dissertation to the distinction between monetary stability and price stability back in 2003! But of course nobody paid much attention to it then …).

Here you will find a video and the slides to the presentation of the Institute in London on the 11th of June (at the Royal Automobile Club), by its Director Tim Congdon. I have had the privilege to contribute to the Institute as one of its Deputy Directors and I do firmly believe there is ample room to both develop ourselves and cooperate with other colleagues and institutions to encourage much more monetary (and monetarist) research in the years to come so we can get a better understanding on the relation between broad money growth, overall inflation, asset price inflation and nominal income. More news and posts on the Institute’s events and agenda will follow.

Juan Castaneda

PS. The Institute’s website has not been chosen randomly of course, mv-pt.org, and requires no further explanation.

The publication of both these posts and the academic article couldn’t be more timely. Surprisingly enough, monetary economists still disagree on the stance of monetary policy (not just in the US but elsewhere) before the outbreak of the Global Financial Crisis; this proves that we, economists, are not even that good at what we were supposed to do well, that is, the ‘prediction’ of the past. Leaving the academic interest of the subject aside, this is a policy question of major concern for all, should we want to contribute to the running of more sound, and more monetary-stability-oriented, monetary policy rules in the years to come. Now there are very good academics suggesting the way to exit QE and to move forward towards a more ‘normal’ monetary environment, and it is thus the perfect time to make the case for a different type of policy rules, those compatible with the fall of prices in a growing economy.

As I wrote as a comment on a recent George Selgin’s entry to this blog, the productivity rule ‘certainly provides solid theoretical basis to support the running of a different type of monetary policy rules; indeed different to the (CPI) inflation stabilising rules applied by all and sundry before 2008, which contributed to the recent crisis as well as to the instability generated in markets in the last years. It is time to apply less active and less inflationary monetary rules, those that allow the price level to reflect changes in productivity during expansions. Rather than focusing on price stability (actually it is most often ‘inflation stability’) we should be focusing on rules that better preserve monetary and financial stability on longer term basis; and the productivity norm is a good example of the latter. They are not going to be the cure for all problems but at least they will not be adding monetary disturbances on top of other (real-side) disturbances and shocks affecting the economy. And this will help agents form their expectations and make their plans.‘

For those unfamiliar with this literature, David Beckworth’s post provides the explanation for why (market or Fed’s) interest rates should be increased whenever productivity raises, so that the market interest rate runs in parallel with the natural interest rate, as Wicksell put it a century ago. Since then, this has been taken as the condition to keep monetary equilibrium in the economy (or at least, to put it more modestly and accurately, to avoid at least major disequilibria in the markets) and thus to prevent from the excess of money creation that so often has contributed to monetary and financial crises in the past as well as to the succession of the so-called boom and bust business cycles. Quoting Beckworth’s words from his recent post, ‘Was monetary policy loose during the last housing boom?’:

‘Note that the rise in the labor force and productivity growth rates both raised the expected return to capital. The faster productivity growth also implied higher expected household incomes. These developments, in turn, should have lead to less saving and more borrowing by firms and households and put upward pressure on the natural interest rate. Interest rates, in short, should have been rising given these large positive supply shocks during this time.‘

And guess what the Fed did during those years of increase in productivity? Focused much more on (a falling) CPI rate of inflation in a growing economy (which shouldn’t be surprising at all), its policy rule didn’t recommend a change in the Fed’s nominal interest rates (at the very best) and later on it kept on cutting them down for years to avoid deflation by all means. It is well time to put the debate on policy rules on the agenda so we dot repeat the same mistakes in the future.

Juan Castaneda

PS. To be fair and fully transparent, let me declare myself any possible conflict of interest (if at all): I am a lecturer at the University of Buckingham and yes, I am a visiting research scholar at Cato (during the spring 2015).